Options Strategies Guide

options trading stategies

Overview

There are 4 fundamental components of options trading: buying puts, selling puts, buying calls, and selling calls. These options can be combined to create many different strategies with different expected profits and losses.

Each strategy here is accompanied by a profit and loss diagram. In these diagrams the vertical axis shows the expected returns. The horizontal axis indicates the price of the underlining security.

The horizontal access indicates the break even point. The dotted line indicates the strike price.

Glossary of Terms

Break-Even Point (BEP)
The underlying security price at which an option strategy results in neither profit nor loss.
Call Option
An option contract that gives the holder the right to buy the underlying security at a specified price for the duration of the contract. This is a bet the price will go up. (bullish / long)
In-the-money / Out-of-the-money
A put option is in-the-money when the strike price is above the price of the underlying security. A call is in-the-money when the strike price is below the price of the underlying security. Out-of-the-money is the opposite.
Long position
A Long positions is when the investor is a net holder of option contracts. This can be bullish or bearish.
Premium
Premiums are the cost the buyer of a put or a call pays to the seller in exchange for the option contract. Similar to insurance premiums. Premiums are set by market forces.
Put Option
An option contract that gives the holder the right to sell the underlying security at a specified price for the duration of the contract. This is a bet the price will go down. (bearish / short)
Short position
A Short positions is when the investor is a net seller of option contracts. This can be bullish or bearish.
Strike price
The strike price is agreed upon price that an underlying security may be bough (in the case of call options) or sold (in the case of put options). This is called exercising a position.
Time decay
The effect on the price of an option contract as the expiration date gets closer.
Volatility
Volatility is a statistical measure of the fluctuation of returns for a given underlying security. Volatility is often measured as either the standard deviation or variance between returns for the same security.

Bullish Strategies

Long Call

In this example, you simply buy call options. Use this strategy when you have a bullish outlook. Risk is limited, but reward is unlimited. Increase in volatility helps this position. Time erosion hurts this position. Break-even point is the strike price plus the premium paid.

Bull Call Spread

In this strategy, you buy 1 call and sell 1 call at a higher strike price. Use this strategy when you have a bullish outlook. Risk is limited and reward is limited. Increase in volatility can help or hurt depending upon the strike prices. Time erosion can help or hurt depending upon the strike price. The break-even point is the long call strike price plus the total premium paid.

Bull Put Spread

To use this strategy, sell 1 put and buy 1 put at a lower strike price but with the same expiry time. Use this strategy when your outlook is bullish or neutral. Risk and reward are limited. Volatility hurts this position. Time erosion helps this position. Break-even point is the sold put strike price minus the credit received.

Covered Call / Buy Write

To use this strategy, buy the underlying security and sell calls for the same number of shares. Use this strategy when your outlook is slightly bullish. Risk is limited buy substantial. Risk is from the risk of the stock price falling. Reward is limited. Increased volatility hurts this position. Time erosion helps this position. Break-even point is the strike price minus the premium received.

Protective / Married Put

To use this strategy, buy 100 shares of the underlying stock then buy 1 put. Use this strategy when your outlook is slightly bullish. Risk is limited. Reward is unlimited. Increased volatility helps this position. Time erosion hurts this position. Break-even is the stock price plus the premium paid.

Cash Secured Short Put

To use this strategy, sell 1 put and hold the cash equal to 100 x time strike price. Use this strategy when your outlook is slightly bullish. Risk is limited, but substantial. Reward is limited. Increased volatility hurts this position. Time erosion helps this position. Break-even is the strike price minus the premium received.

Bearish Strategies

Long Put

To use this strategy, buy a put. Use this strategy when you expect the price of the underlying asset to fall. Risk is limited. Reward is limited but substantial. Increased volatility helps this position. Time erosion hurts this position. Break-even is the strike price minus the premium paid.

Bear Put Spread

To use this strategy, sell one put and buy 1 put at a higher strike price. Use this strategy when you expect the price of the underlying asset to fall. Risk is limited. Reward is limited. Increased volatility helps or hurts depending upon strike prices. Time erosion helps or hurts depending upon strike prices. Break-even is strike price of the purchased put minus the total premium paid.

Bear Call Spread

To use this strategy, sell one call and buy 1 call at a higher strike price. Use this strategy when your outlook is slightly bearish. Risk is limited. Reward is limited. Increased volatility hurts position slightly. Time erosion helps position slightly. Break-even is strike price of the sold call plus the premium received.

Neutral Strategies

Collar

To use this strategy, you must own the underlying security then purchase 1 put and sell 1 call at a higher strike price. This is strategy when your outlook is neutral. Risk is limited. Reward is limited. Increased volatility does not effect the position in most cases. Time erosion does not effect the position in most cases. The break-even point is between the strike price of the put and call.

Short Saddle

To use this strategy, you sell one call and sell one put at the same strike price. This is strategy when your outlook is neutral. You are betting the price does not move much. Risk is unlimited. Reward is limited. Increased volatility hurts this position. Time erosion helps this position. There are two break-even points. One is the call strike price plus the premium received. The other is the put strike price minus the premium received.

Short Strangle

To use this strategy, you sell 1 call at a higher strike price and sell 1 put at a lower strike price. This strategy has a neutral outlook. Risk is unlimited. Reward is limited. Increased volatility hurts this position. Time erosion helps this position. There are two break-even points. One is the call strike price plus the premium received. The other is the put strike price minus the premium received.

Iron Condor

To use this strategy, you have to buy 2 options and sell 2 options. You sell 1 call and buy 1 call at a higher strike price. Then you sell 1 put and buy 1 put at a lower strike price. All options should have the same expiry time. The price of the underlying should be between the the short call and the short put strike prices.

This strategy has a neutral outlook. Risk is limited and reward is limited. Increased volatility hurts this position. Time erosion helps this position. The break-even points are the short call strike plus premium received or the short put strike minus premium received.

Volatility Strategies

Long Saddle

This is the opposite of a short saddle. To use this strategy, you buy 1 call at a higher strike price and buy 1 put at the same strike price. This strategy has a neutral outlook. Risk is limited. Reward is unlimited. Increased volatility helps this position. Time erosion hurts this position. There are two break-even points. One is the call strike price plus the premium received. The other is the put strike price minus the premium received.

Long Strangle

This is the opposite of a short strangle. To use this strategy, you sell 1 call at a higher strike price and sell 1 put at a lower strike price. This strategy has a neutral outlook. Risk is limited. Reward is unlimited. Increased volatility helps this position. Time erosion hurts this position. There are two break-even points. One is the call strike price plus the premium received. The other is the put strike price minus the premium received.


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